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Economist and Nobel laureate Paul Krugman took a break from Keynesian economics to blog about his thoughts on Apple (NASDAQ: AAPL) and Microsoft (NASDAQ: MSFT) . Krugman, by his own admission, is not much of a tech observer. But his conclusion -- that Apple may in fact be more challenged than Microsoft -- is largely based on an easily observable economic phenomenon.

Network effects -- the notion that a product becomes more useful based on the number of users -- permeates the tech landscape, and remains the driving force behind the business model of many tech firms, particularly Apple and Microsoft.

Network externalities are crucial when it comes to operating systemsWhen companies are dependent on the sale of operating systems, they are beholden to the nature of network effects. Windows, for example, has no value in and of itself other than its ability to serve as a platform to run other programs.

A consumer buys a Windows PC because most of the PC software in the world has been written to run on Windows computers. The more people own Windows computers, the more software is likely to be written for Windows, and thus the more valuable a Windows PC becomes.

Krugman's take on the Apple business modelLosing Windows would hurt Microsoft's business, no doubt, but it isn't Microsoft's whole business by a long shot. In contrast, Apple's entire business is built around its mobile operating system. iOS powers Apple's iPhones and iPads, which account for the overwhelming majority of the company's revenue and profit.

If these devices ran a competing operating system, consumers would be unlikely to buy them. For the prices Apple charges, its products are technologically inferior to the competition. But if you want iOS, you have no choice but to buy Apple products.

Consumers want iOS in large part due to its app ecosystem. Krugman writes that a deeper bench of apps appears to be iOS' primary advantage:

Now, unlike Microsoft, Apple isn't selling an inferior product. But it's selling products that are little if any better than competitors, at premium prices. How can it do that? Again, network externalities: mainly a much deeper bench of apps.

That's definitely the case, and there's a litany of examples to prove it. Most recently, Electronic Arts' decision to make Plants vs Zombies 2an iOS exclusive (for the time being).

Consumers vs IT managersKrugman argues that, on a comparative basis, Apple's lock on the mobile market is much less concrete than Microsoft's lock on the traditional PC market, primarily for one reason: As an enterprise company, Microsoft has historically sold to the heads of IT departments.

Given the nature of corporate bureaucracies, IT departments are much more likely to stick with a platform. In contrast, individual consumers can be fickle. By focusing on selling directly to the consumer, Apple may have built a larger cultural footprint than Microsoft, but it's more susceptible to shifts in consumer preference.

BYOD blurring the lineKrugman offers no supporting evidence for his theory, though it appears to make sense intuitively. However, the notion of IT departments calling the shots when it comes to electronic preferences is fading fast.

For example, consider BlackBerry. For the most part, its business model was built on selling phones to the very IT heads Krugman believes are too conservative to make a change. Yet, that didn't stop Apple coming in and destroying BlackBerry's business. The trend of bring-your-own-device eviscerated any protection BlackBerry had when it came to corporate loyalty.

Android could replace both iOS and WindowsWhat Apple did to BlackBerry, Google (NASDAQ: GOOGL) could do to both Windows and iOS. The growth of Android's market share has been nothing short of astounding in recent years, with Android phones now accounting for about 80% of the smartphones sold worldwide.

But Android's dominance could extend beyond just the phone. Research firm Gartner said back in April that it expects Android to obliterate Windows within four years. Although Android may never become a desktop operating system, the growth of tablets and smartphones has had some cannibalizing effects on traditional PCs.

For Windows, it might only be a matter of time. But for iOS, it's a bit trickier.

Android surpassed iOS in market share for the first time over two years ago. Yet, developers continue to flock to iOS when it comes to making new apps. As long as that software gap exists, iOS is likely to remain relevant.

Operating systems and network effects

As Krugman observes, companies that depend on selling operating systems rely on network effects -- operating systems only have value if they're widely used. Once dominance in an operating system is established -- like Windows in the PC realm -- it's hard to break, as the large software library makes switching to a rival system nearly impossible.

With Android's exploding market share, iOS' advantage in terms of software might not always be there. As Krugman notes, it will be difficult for Apple to sell its relatively expensive products if its operating system does not have the edge. If Android finally becomes the premiere mobile-developer platform, Apple could have much to lose.

But as long as Apple maintains its app advantage over Android, it should have nothing to fear.

Comments from our Foolish Readers

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I am a great fan of Krugman, but I do think that his comment that he neither uses Apple products or understands why one would prefer a product that is not "ugly" says it all. Many of us who have used Apple products for many years clearly understand why Apple products sell well. They usually work rather well and seamlessly with one another and they add to the beauty of our work environment rather than being just another piece of ugly junk. It is perfectly fine for others to buy using a different set of criteria, but I think that Apple will be fairly successful for several more years. We will see!

Paul who? I suppose he has discounted the entire computer line and the revolution in how music and media are distributed. Does he have any insight into the pipeline or expanding markets? He should stick to his left-wing lunacy.

When did Apple destroy Blackberry's business? BYOD is people not important enough to get a company paid Blackberry bringing their iPhone to work for basically just company email, which save the company money. Every day we read some company outfitting their executives with new Blackberrys, just as Krugman as deduced; not changing what works.

PS.... Just watch TV which mirrors life. All the British and some American detective and police shows have the detectives and upper police management using Blackberrys, while the street cop is using their own phone.

It amazes me that Paul Krugman's comments continue to be reported on. How well are the Keynesian economics, as prescribed by Paul, working out for this country? It is putting our children, and grandchildren with unsustainable debt levels, with negative traction. And now, we are to write off Apple because this genius, who admittedly knows nothing about technology, says it is going to be derailed by Microsoft, are you kidding me? Hello, Paul, did you ever stop to think that they can afford to charge more because they offer a superior product? Do you know why more apps are made for Apple products than any other? Paul, if you truly believe that Apple is going to be irrelevant, please take your Nobel laureate winnings, short the stock, and come back here and confirm it. I will put my money up against yours! Here's my prediction: Your Keynesian economics advice is going to bankrupt the U.S. Time will tell who will be more accurate.

I suppose if apple's business model remains the same for another 20 years it could be a problem. I rather doubt that would be the case. Models change as the needs of the customers change. In the next few years apple will continue to earn tens of billions of dollars in profits based on the current model. Who knows 5 years from now what apple will be worth. It is possible they could have three or four hundred billions of dollars stashed away. If that were the case they would have the power to do anything and everything they want as a company. The device company they are today could be history and they could be a different type of company. Money will give them that power. I think people underestimate what the future holds for apple the company.

I love Krugman, but clearly he is not a tech wonk. I don't buy Apple for the OS. I buy it rather for the technological superiority, which Krugman thinks it does not have. The recently released MacBook Air is a great example--nothing in its class. As for my Mac Pro, lightning fast, doesn't get viruses, very rugged (my last computer, a PC, needed a new screen and keyboard after a year, and was slow as a snail to boot [no pun intended]. I like my time machine automatic hourly backups--have rescued me a time or two already. I'm no Mac fanatic--I have a Samsung Galaxy phone--but I do have an iPod, and have had the same one for years. Apple products need replacing less often and have an excellent service record--not to mention that Apple is tops in customer service. Hardware superiority is the only reason I need to buy a Mac.

Mr. Krugman makes a mistake in focusing entirely on the "app advantage" when it comes to Apple. Apple has done quite a good job in "gluing" together its devices with useful services (e.g. AirPlay, Photostream, iCloud backup) that are proprietary to its ecosystem and which customers will find increasingly difficult to leave behind. I believe it is one of the reasons why more people move from Android to iOS than the other way around!

Mr. Krugman also ignores that while Microsoft solely relied on the network effect to drive the growth of its Windows OS, Apple (and Google) also garners income from every application sold (30% of sale price in case of Apple's app store). The more applications written for iOS, the more money Apple makes. Unlike Google, Apple has an iron fist over its app store and can, thus, enforce app quality and security (80% of all mobile viruses target Android - only 0.7% target iOS). Google can't do anything about malware proliferation because it, like Microsoft, does not control app distribution. Apple does. People increasingly know this. It is one of the reasons iTunes does so well relative to Android - even when Android has 80% of the smartphone market.

Apple products are for pleasure. Sure you can do work on Apple products, but they are not the standard for business. To rephrase, Apple product sales result from personal opinion about what is fun. I have an Apple laptop and iPhone, and they are fun, and they eat my time. When I want to get work done I use my PCs. Eventually something will come along that is more fun than Apple products. Maybe Krugman Komputers.

Krugman is an idiot, pre and simple. He and Balmer must lunch together often to share their insights into what is going on in the technology world. Neither has a clue.

Do you know why developers prefer to write for IOS, Paul? MONEY, PAUL. Your supposed area of expertise. IOS users spend money on IOS Apps, returning them a profit. Android users do not, they want everything free. That's why Apple makes way more money for IO S developers than Android developers do. Even though they have far less market share. In addition, the days of IT Departments having absolute control over things are dead and gone. Between BYOD and when the CEO has an iPhone, they will support IOS. You really do have a cerebral rectal incersion.

This is probably the ONLY think I will ever agree with Krugman on as I have never owned an Apple product or a Mac (e.g. who wants to learn a new operating system that's not compatible with what most other people use?) and I probably never will as there are CHEAPER options out there for my more limited or basic needs....

The whole premise of Krugman's argument is based on the assumption that both Apple and Microsoft are standing still thus other's can swoop in and overtake them. The reality is both companies are constantly moving forward.

@A700 - but Apple has always sold their products to schools at a huge discount, since at least the lat 80s. It's no different now. I'm sure they give them those iPads at cost.

As far as the ide athat "Android could replace both iOS and Windows" --- that wold be a crying shame. I use an Android phone now and I'm little pleased with it. In fact I think of all the OS's out there Android is probably the one with the least strongest customer loyalty. Many people buy it because it's cheap and readily available and it works good enough.

Apple is always doomed, according to somebody. I very highly doubt any of us will ever see a day where Apple DOESN'T post a gigantic profit at the end of a quarter. I'm sure we'll all be dead before that happens.

@EmergingMrktSkpt: I've had Mac computers for the last 5 years or so and have not had a single task I couldn't accomplish. Especially with programs like Parallels or Apples own bootcamp that allows Windows to run on a Mac. The days of Macs not being compatible with peoples needs are long gone.

Most of the people here complaining about Krugman don't actually appear to have read his actual blog post, and are instead going on Motley Fool's poor paraphrasing of this statements. I suggest actually reading Krugman's post because many of the statements attributed to him are false. He never said Apple was doomed.

Krugman's actually got it right. It's fundamentally a market share argument, but it's based on the fact that all ecosystems, no matter how profitable, need market share to remain attractive and relevant to the large numbers of third party developers who depend on it.

In order to appreciate why his point of view is correct, you have to pay attention to the global trends in the app market. The app-driven smartphone got its start in the highly subsidized US mobile phone market and then spread outward as device costs fell to the point where folks around the world could afford to buy unsubsidized smartphones. US developers have been the primary producers of apps used around the globe as a result. However, this is beginning to change radically as Android gains a massive billion+ following outside the US that iOS will never come close to matching. Foreign developers will eventually overtake US developers in app production by a huge margin. They will be making apps that appeal much more to their local and regional audience than apps made by US developers who have no real clue as to what apps folks outside the US actually want. Because of the high cost of iOS devices and the resulting poor adoption rates of iOS in most populous countries, fewer of these foreign developers will bother to create iOS versions of their apps, cementing Android's complete dominance over iOS in each territory. The typical mobile user outside the US will eventually think twice before paying large sums for an iPhone or iPad because large numbers of the locally relevant apps that their friends and family are using will not be available for them in Apple's store. This is when Apple's lack of global market share will begin to really affect its profitability.

This is essentially what Krugman is alluding to. Already, as Android surges in China, the Chinese developers are making apps that appeal much more to their local audience than Apple's App store apps that are popular among US consumers. For now, they're making both Android and iOS apps, but many of these iOS versions are not available in Apple's App store. This is why Apple's iPhones currently have a jailbreak rate of over 42% in China. As the situation I described above becomes the norm around the world, you'll see a greater tendency among users of i-products outside the US to jailbreak them just as they are already doing in China. As the situation worsens, more and more just won't buy them anymore.

Who missed this? "Krugman, by his own admission, is not much of a tech observer"

If this is the case, why is he even opening his mouth? He is a Nobel Laureate for economics, not technology. If he tells me not to buy Apple stock, I will listen but, if he tells me they are in trouble, he's an idiot. Yeah, Microsoft came out with the first touch screen but, it sucked and bad!

It always amazes me how much the brand loyalty to Apple obscures logical thought. I love Apple products, but Network Effects and Externalities are a reality that drive all businesses. All PK is suggesting, from an economic systems perspective, is that if nothing else changes in current market trends, then the liklihood of Apple beating Windows or Android in the long term are very low. Nothing more and an accurate assessment IN THAT NETWORK MODEL.

The reality is that NETWORK MODELS change, e.g. access to China Mobile subscribers and the launch of an iPhone5C that appeals to 1.5B bargain and brand conscious Chinese consumer change the inputs to the Network model and predict a different outcome (increased iOS reach, more regionalized Apps, etc.) increased share.

In the model PK postulated, the recent data supports his assertion. iOS based iPhone and iPad shares continue to decline over sequential quarters, at the expense of Android based phones and tablets from Samsung, Lenovo (who btw is the 3rd largest smartphone producer in the world, and has yet to sell a phone outside of China).

The other dynamic that the Network model doesnt address is value. Consumers pay for brand and technology. The recent performance of Apple and Samsung products shows that incrementalism in new products for this market don't hold pricing value. In the absence of a technology disrupter (seriously, would you pay $600 for a Motorola xphone just to have your choice of push button colors?) a far larger % of consumers wont pay the premium for a Galaxy or iPhone platform in any regional market.